The following analysis is intended to help the reader understand our results of operations and financial condition, and should be read in conjunction with our consolidated financial statements and the accompanying notes located in Item 8 of this Form 10-K.




                                       23


Overview

We are a nationwide franchisor of offices providing on-demand labor solutions in the light industrial and blue-collar segments of the staffing industry. We were formed through the merger between Hire Quest Holdings, LLC ("Hire Quest Holdings") and Command Center, Inc. We refer to Hire Quest Holdings and its wholly-owned subsidiary, Hire Quest, LLC, collectively as Legacy HQ. We refer to this merger, which closed on July 15, 2019 as the Merger. As of December 31, 2019 we had 147 franchisee-owned offices in 32 states and the District of Columbia. We provide employment for an estimated 67,000 individuals annually working for thousands of clients in many industries including construction, recycling, warehousing, logistics, auctioneering, manufacturing, hospitality, landscaping, and retail.

Recent Developments

We expect the recent coronavirus pandemic to have a significant impact on our operations. In March, 2020, infections of the coronavirus ("COVID-19") had become pandemic with persons testing positive in all fifty states and the District of Columbia. With widespread infection in the United States and abroad, national, state, and local authorities have recommended social distancing andhave taken dramatic action including, without limitation, ordering the workforce to stay home, banning all non-essential businesses from operating, refusing to issue new building permits, and invalidating current building permits causing work to stop. These measures, while intended to protect human life, are expected to have serious adverse impacts on domestic and foreign economies of uncertain severity and duration. The effectiveness of economic stabilization efforts, including proposed government payments to affected citizens and industries, is uncertain. Some economists are predicting the United States will soon enter a recession.

The sweeping nature of the COVID-19 pandemic makes it extremely difficult to predict how our business operations will be affected in the long term. But the likely overall impact of the pandemic is viewed as highly negative to the general economy. Already, the COVID-19 outbreak has begun to neagitvely impact our operations and revenue as well as those of our franchisees. We expect the effects to become more acute in the next few months. It is possible that a number of our offices may be forced to close. To date, our franchisees have closed or consolidated a small number of offices at least, in part, due to the potential financial impacts of COVID-19. Some of our franchisees may experience economic hardship or even failure. In general, those franchisees whose businesses are oriented towards construction, manufacturing, logistics, or waste services have been less impacted to date than those whose businesses are more focused on hospitality services. We have already witnessed a significant drop in the amount of hospitality, event service, and catering business that our franchisees do. Our other lines of business may suffer in the future as well. For example, we may be classified as a non-essential business in some or all of the jurisdictions that impose a ban on non-essential businesses. If that were to occur, we may be forced to temporarily or permanently close offices in those jurisdictions. Our customers may choose to voluntarily close their worksites. We may also experience a shortage of temporary employees as a result of the spread of the disease.

Any of the above factors, or other cascading effects of the coronavirus pandemic that are not currently foreseeable, could materially negatively impact our revenue, net income, and other results of operations, reduce system-wide sales, cause office closings or cause us to lose franchisees, and impact our liquidity position, possibly significantly. The duration of any such impacts cannot be predicted.

We underwent the following significant changes in 2019 which we expect to have a material impact on our operations: (1) we completed the Merger between Legacy HQ and Command Center and subsequently reincorporated in Delaware, (2) in connection with the Merger, we entered into a new credit facility with Branch Banking & Trust, (3) we entered into a consulting agreement with Dock Square HQ, LLC, (4) we converted all of the company-owned offices, acquired during the Merger, to our franchise model, and (5) we exited the California market for strategic reasons.

The Merger, the Name Change, and the Reincorporation in Delaware

On July 15, 2019, Legacy HQ and Command Center completed the Merger.

Upon closing, the ownership interests of Hire Quest Holdings were converted into the right to receive a number of shares amounting to 68% of the total shares of the Company's common stock outstanding immediately after the closing. Legacy HQ members also appointed four new directors to the Board effective July 15, 2019 to fill the board seats vacated by four legacy Command Center directors.

On September 11, 2019, Command Center changed its name to HireQuest, Inc. We reincorporated in Delaware, consolidated our corporate headquarters in Goose Creek, South Carolina, and adopted new bylaws. In connection with the name change, we started trading as "HQI" on the Nasdaq Capital Market.

The New Credit Facility

On July 11, 2019, in connection with the Merger, we, along with our subsidiaries, entered into a loan agreement with Branch Banking and Trust Company, now Truist Bank ("BB&T"), for a $30 million line of credit with a $15 million sublimit for letters of credit. Interest will accrue on the outstanding balance of the line of credit at a variable rate equal to One Month LIBOR plus a margin between 1.25% and 1.75% that is determined based on the Company's collateral value plus unrestricted cash reduced by the outstanding balance of the line of credit. This amount is referred to as the Net Lendable Collateral. A non-use fee of between 0.125% and 0.250%, also determined by the Net Lendable Collateral, will accrue on the unused portion of the line of credit. The available balance under the line of credit is reduced by outstanding letters of credit. The line of credit is scheduled to mature on May 31, 2024.

The loan agreement and other loan documents contain customary events of default and negative covenants, including but not limited to, terms governing indebtedness, liens, fundamental changes, transactions with affiliates, and sales of assets. The loan agreement also requires us to comply with a fixed charge coverage ratio of at least 1.10:1.00. This covenant will be tested quarterly on a rolling four quarter basis commencing with the four quarter period ending September 30, 2020. The obligations under the loan agreement and other loan documents are secured by substantially all of the operating assets of the Company and our subsidiaries as collateral. The Company's obligations under the line of credit are subject to acceleration upon the occurrence of an event of default as defined in the loan agreement.

Command Center's prior credit facility with Wells Fargo was paid off and terminated in connection with the transaction described above.

The Dock Square Consulting Agreement

Dock Square HQ, LLC ("Dock Square"), an affiliate of Dock Square Capital, LLC, was a strategic partner of, and 6.5% investor in, Hire Quest, LLC, then a 93.5% subsidiary of Hire Quest Holdings. Prior to the effective time of the Merger, (a) Dock Square distributed to its direct or indirect members all of its rights, title and interest in and to its membership interest in Hire Quest, LLC, and (b) each such member contributed to Hire Quest Holdings all of its respective rights, title and interest in and to its membership interest in Hire Quest, LLC as a capital contribution in exchange for, in the aggregate, a 6.5% membership interest in Hire Quest Holdings. Immediately after such reorganization and prior to the closing of the Merger, Hire Quest Holdings owned 100% of the membership interests in Hire Quest, LLC.




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As contemplated by the Merger Agreement, on July 15, 2019, the Company entered into a consulting arrangement with Dock Square. Pursuant to this consulting arrangement, Dock Square introduces prospective customers and expands relationships with existing customers of the Company in return for which it is eligible to receive unregistered shares of the Company's common stock, subject to certain performance metrics and vesting terms. The grant of any such shares by the Company would be based on the Company's gross revenue generated from the services of Dock Square as measured over a 12 month period. Upon the grant of any such shares, 50% of such granted shares would vest immediately, and the remaining 50% of such granted shares would be subject to a vesting requirement linked to the Company's gross revenue generated from the services of Dock Square measured over a 3 year period. We refer to any such shares as the "Performance Shares." We anticipate the maximum aggregate number of Performance Shares issuable under the consulting arrangement would not exceed approximately 1.6 million shares. Any Performance Shares would be in addition to the pro rata portion of the shares of Company common stock that Dock Square's members received as merger consideration at the closing of the Merger along with the other investors in Hire Quest Holdings. Dock Square would receive any declared and paid dividends on issued Performance Shares, including the unvested portion of such shares during the 3-year vesting measurement period, and the issued but unvested Performance Shares would vest on a change of control of the Company. In addition, Dock Square received piggy-back registration rights with respect to its Performance Shares issued and vested at the time of such registration. As of December 31, 2019, no Performance Shares have been granted under this agreement as the required metrics have not been met.

Franchise Model Conversion

On July 15, 2019, we sold the operating assets of the offices in Conway and North Little Rock, AR; Flagstaff, Mesa, North Phoenix, Phoenix, Tempe, Tucson, and Yuma, AZ; Aurora and Thornton, CO; Atlanta, GA; College Park and Speedway, IN; Shreveport, LA; Baltimore and Landover, MD; Oklahoma City and Tulsa, OK; Chattanooga, Madison, Memphis, and Nashville, TN; Amarillo, Austin, Houston, Irving, Lubbock, Odessa, and San Antonio, TX; and Roanoke, VA to existing franchisees of Legacy HQ (including the Worlds Franchisees described below) and new franchisees. On September 29, 2019, we sold the operating assets of the offices in Coeur D'Alene, ID; Griffith, IN; Bloomington, Brooklyn Park, Cambridge, Hopkins, St. Paul, and Wilmar, MN; Bismarck, Dickinson, Fargo, Grand Forks, Minot, Watford City, and Williston, ND; Bellevue and Omaha, NE; Hillsboro, OR; Sioux Falls, SD; and Bellingham, Everett, Kent, Mt. Vernon, Seattle, Spokane, Tacoma, and Vancouver, WA to a new franchisee. The purchasers of these assets, or their related entities, executed franchise agreements with us and became franchisees.

The aggregate sale price for the operating assets of the offices sold on July 15 and September 29, 2019 consisted of approximately (i) $12.1 million paid in the form of promissory notes accruing interest at an annual rate of 6% plus (ii) the right to receive 2% of annual sales in excess of $3.2 million in the aggregate for the franchise territory containing Phoenix, AZ for 10 years, up to a total aggregate amount of $2.0 million. Approximately $2.2 million of the notes receivable were sold to Hire Quest Financial, LLC, a related party, in exchange for accounts receivable of an equal value. In addition, we received $3.0 million in cash as prepayment on the notes issued on September 29, 2019. In accordance with an agreement with the buyer, an unrelated franchisee, this cash payment also triggered a discount in the purchase price equal to 10% of the cash payment, or $300,000.

We have recognized the operations of company-owned offices within discontinued operations. Any additional expenses incurred related to previously company-owned offices will continue to be recognized as part of discontinued operations in future periods. This conversion of company-owned offices to franchises will likely have a material impact on the presentation of our results of operations in the future with revenue from franchise royalty fees and service revenue increasing and income from discontinued operations, net of tax decreasing to zero by the end of the first quarter of 2020.

Exiting the California Market

On September 27, 2019, we closed on the sale of substantially all of the operating and intangible assets of our four offices in Corona, Hayward, Sacramento, and Fresno, California (collectively, the "California Assets"). We retained the net working capital of these offices. We sold these operating and intangible assets outside of the franchise system and do not intend to sell franchises in California in the near future.

The aggregate sale price for the California Assets consisted of $1.8 million paid in the form of a four-year promissory note accruing interest at an annual rate of 10% issued by the buyer to the Company.




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Effect of the Merger on the Presentation of Our Financial Statements

In accordance with ASC 805, Business Combinations, we accounted for the Merger as a reverse acquisition. As such, Legacy HQ is considered the accounting acquirer. Accordingly, Legacy HQ's historical financial statements replace Command Center's historical financial statements following the completion of the Merger, and the results of operations of both companies are included in our financial statements for all periods beginning July 15, 2019.

Results of Operations



The following table displays our consolidated statements of operations for the
years ended December 31, 2019 and December 31, 2018 (in thousands, except
percentages):


                                                 Year ended


                                                 December 31, 2019  December 31, 2018

Franchise royalties                               $14,674    92.4%   $11,287    91.5%
Service revenue                                   1,202      7.6%    1,043      8.5%
Total revenue                                     15,876     100.0%  12,330     100.0%

Selling, general and administrative expenses 12,692 80.0% 5,325 43.1% Depreciation and amortization

                     400        2.5%    93         0.8%
Income from operations                            2,784      17.5%   6,912      56.1%
Other miscellaneous income                        751        4.7%    190        1.4%
Interest and other financing expense              (560)      (3.5%)  (20)       (0.1%)
Net income before income taxes                    2,976      18.7%   7,082      57.4%
Provision for income taxes                        3,481      21.9%   21         0.2%

Income (loss) from continuing operations (505) (3.2%) 7,061 57.2% Income from discontinued operations, net of tax 215 1.4% 56 0.4% Net income (loss)

$(290)     (1.8%)  $7,117     57.6%



Total Revenue
Our total revenue consists of franchise royalties and service revenue.

Total revenue for the year ended December 31, 2019 was approximately $15.9 million compared to $12.3 million for 2018, an increase of 28.8%. This increase was largely driven by organic growth among offices not acquired through the Merger which amounted to 58% of the total increase. Total revenue growth directly attributable to the offices acquired during the Merger, which closed in July, and their subsequent conversion to franchises, amounted to 42% of the increase.Because we significantly increased the number of franchised offices, we increased both our royalty revenue and our service revenue.

Sales at company-owned offices are not reflected in revenue, but are reflected net of costs, expenses, and taxes associated with those sales as "Income from discontinued operations, net of tax."

Franchise Royalties We charge our franchisees a royalty fee on gross billings to customers on the basis of one of two models: the HireQuest Direct model, and the HireQuest model. Under the HireQuest Direct model, the royalty fee charged ranges from 6% of gross billings to 8% of gross billings. Royalty fees are charged at 8% for the first $1,000,000 of billing with the royalty fee dropping ½ of 1% for every $1,000,000 of billing thereafter until the royalty fee is 6% once gross billings reach $4,000,000 annually. The smaller royalty fee is charged only on the incremental dollars resulting in an actual royalty fee at a blended rate of between 6% and 8%. We grant our franchisees credits for low margin business. For the HireQuest business line, our royalty fee is 4.5% of the temporary payroll we fund plus 18% of the gross margin for the territory.




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Our franchise royalties increased approximately $3.4 million, or 30.0%, from $11.3 million in 2018 to $14.7 million in 2019. Of this increase, 57% was due to growth unrelated to the Merger and 43% arose from the offices we acquired through the Merger.

Service Revenue Service revenue consists of interest we charge our franchisees on overdue customer accounts receivable and other miscellaneous fees for optional services we provide. As accounts receivable age over 42 days, our franchisees pay us interest on these accounts equal to 0.5% of the amount of the uncollected receivable each 14 day period. Accounts that age over 84 days are charged back to the franchisee and are not charged interest.

Service revenue for the year ended December 31, 2019 increased approximately $160,000, or 15.4%, from approximately $1 million in 2018 to approximately $1.2 million in 2019. 72% of this additional revenue arose from organic growth. The offices we added through the Merger accounted for 28% of the increase.

Selling, General, and Administrative Expenses ("SG&A") SG&A increased by approximately $7.4 million, or 138.4%, in 2019 to $12.7 million from $5.3 million in 2018. Nearly 70% of this increase was due to Merger-related expenses. The significant Merger-related expenses include professional fees of approximately $1.8 million for investment bankers, attorneys, and other professionals, $1.9 million of non-recurring compensation including severance payments and accelerated vesting of stock, $835,000 for reorganizational and rebranding expenses, and $566,000 in other non-recurring expenses mostly related to Command Center's headquarters lease, which we terminated in December 2019 and associated costs. SG&A expenses unrelated to the Merger include a $758,000 increase in stock based compensation and $370,000 in increased legal and professional fees related to the operation of a public company.

Provision for income tax Provision for income taxes for the year ended December 31, 2019 was approximately $3.5 million. The difference was primarily due to a one-time, Merger related charge of approximately $4.0 million. Prior to the Merger, Legacy HQ had a significant amount of uncollected accounts receivable. As a cash-basis taxpayer, Legacy HQ did not owe taxes on those uncollected accounts. When Legacy HQ merged into and became a part of a public company, it was required to switch to the accrual basis of accounting and changed its tax status from a partnership to a corporation. Accordingly, we recognized a provision for the taxes which would become due related to these changes.

Income from discontinued operations, net of tax Income from discontinued operations, net of tax, was $215,000 for the year ended December 31, 2019 compared with $56,000 for the year ended December 31, 2018. The increase was due to our owning certain offices from the date of the Merger through the date they were sold to franchisees or, in the case of California offices, to an independent third party.

Liquidity and Capital Resources

Our major source of liquidity and capital is cash generated from our ongoing operations consisting of (a) royalty revenue and (b) service revenue, including interest charged on overdue accounts receivable and other fees for optional services. We also receive interest on notes receivable that we issued in connection with the conversion of company-owned offices to franchised offices. In addition, we have the capacity to borrow under our line of credit with BB&T.

At December 31, 2019, our current assets exceeded our current liabilities by approximately $26.0 million. Our current assets included approximately $4.2 million of cash and $28.2 million of accounts receivable, which our franchisees have billed to customers and which we own in accordance with our franchise agreements. Our largest current liabilities include approximately $3.6 million due to our franchisees, $2.3 million related to our workers' compensation claims liability, and $1.8 million due in relation to our risk management incentive program.




                                       27

Our working capital requirements are driven largely by temporary employee payroll and accounts receivable from customers. Since receipts lag behind employee pay - which is typically daily or weekly - our working capital requirements increase as system-wide sales increase.

We believe that our future cash generated from operations, together with interest income from outstanding notes receivable and our capacity under our existing line of credit with BB&T, will provide adequate resources to meet our working capital needs and cash requirements for at least the next 12 months. For a discussion of our credit facility with BB&T, and the related loan agreements, please refer to "Recent Developments - The New Credit Facility" in this Item 7, which disclosure is incorporated herein by reference. Our access to, and the availability of, financing on acceptable terms in the future will be affected by many factors including overall liquidity in the capital or credit markets, the state of the economy and our credit strength as viewed by potential lenders. We cannot provide assurances that we will have future access to the capital or credit markets on acceptable terms. The impact of the COVID-19 crisis on availability of capital or credit is difficult to predict and may be significant.

Operating Activities Net cash used in operating activities from continuing operations was approximately $5.0 million for the year ended December 31, 2019. Operating activity for the year included significant Merger-related SG&A expenses which contributed to a net loss from continuing operations of approximately $505,000. Other uses of cash included an increase in accounts receivable of approximately $7.5 million and a decrease in accrued benefits and payroll taxes of approximately $1.4 million. These uses were offset by an increase in our workers' compensation claims liability of approximately $2.0 million, a decrease in prepaid expense and other current assets of approximately $1.6 million, and an increase in the amount due to our franchisees of approximately $1.2 million. Net cash provided by operating activities was approximately $5.1 for the year ended December 31, 2018 and included net income of approximately $7.1 million. This was offset by a decrease in the amount due to our franchisees of approximately $1.5 million.

Investing Activities Net cash provided by investing activities was approximately $9.8 million for the year ended December 31, 2019. This was largely due to the cash acquired in the Merger of approximately $5.4 million and payments on notes receivable of approximately $3.6 million. These provisions were offset by the purchase of property and equipment of approximately $507,000. Net cash provided by investing activities was approximately $154,000 for the year ended December 31, 2018. This was largely related to the sale of property and equipment.

Financing Activities Net cash used by financing activities was approximately $11.9 million for the year ended December 31, 2019. This use was largely due to the purchase of stock of approximately $8.4 million pursuant to the tender offer made by the Company in conjunction with the Merger and payments to affiliates of approximately $5.5 million. This use was offset by net contribution of Legacy HQ members of approximately $1.2 million. Net cash used by financing activities was approximately $4.2 million for the year ended December 31, 2018. This was largely related to distributions to Legacy HQ members of approximately $7.0 million. This use was offset by an increase in the amount due to affiliates of approximately $2.8 million.

System-Wide Sales

We sometimes refer to total sales generated by our franchisees as "franchise sales." We also sometimes refer to offices that we owned and operated for a period prior to their sale to franchisees, the last of which closed on September 29, 2019 as "company-owned offices." Sales at company-owned offices are reflected net of costs, expenses, and taxes associated with those sales on our financial statements as "income from discontinued operations, net of tax." We refer to the sum of franchise sales and sales at company-owned offices as "system-wide sales." System-wide sales include sales at all offices, whether owned and operated by us or by our franchisees. System-wide sales is a non-GAAP measure. While we do not record franchise sales as revenue, management believes that information on system-wide sales is important to understanding the Company's financial performance because those sales are the basis on which we calculate and record franchise royalty revenue, are directly related to interest charged on overdue accounts, which we record under service revenue, and are indicative of the financial health of the franchisee base. System-wide sales are not intended to represent revenue as defined by generally accepted accounting principles in the United States ("U.S. GAAP"), and such information should not be considered as an aternative to revenue or any other measure of performance prescribed by U.S. GAAP.

The following table reflects our system-wide sales broken into its components for the years ended December 31, 2019 and 2018:

December 31, 2019 December 31, 2018

Franchise sales $227,691,668 $189,293,776 Company-owned sales 13,932,769 722,849 System-wide sales $241,624,437 $190,016,625

System-wide sales were $241.6 million in 2019, up $51.6 million or 27.2%. The increase in system-wide sales arose largely from organic growth and from the offices added in July 2019 via the Merger, which were subsequently sold as franchisees.




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Number of Offices

We examine the number of offices we open and close every year. The number of offices is directly tied to the amount of royalty and service revenue we earn. On a net basis, we added 50 offices in 2019 by opening or acquiring 60 and closing 10 offices. Acquired offices are presented below after subtracting acquired offices which were consolidated into existing offices. The vast majority of the additions arose from the Merger. In 2018, we added 18 offices on a net basis by opening 21 and closing 3.

The following table accounts for the number of offices opened and closed in 2018 and 2019.



Franchised offices, December 31, 2017  79
Closed in 2018                         (3)
Opened in 2018                         21
Franchised offices, December 31, 2018  97
Closed in 2019                         (10)
Acquired in 2019                       52
Opened in 2019                         8

Franchised offices, December 31, 2019 147

Seasonality

Our revenue fluctuates quarterly and is generally higher in the second and third quarters of our year. Some of the industries in which we operate are subject to seasonal fluctuation. Many of the jobs filled by employees are outdoor jobs that are generally performed during the warmer months of the year. As a result, in an average year, activity increases in the spring and continues at higher levels through summer, then begins to taper off during fall and through winter.

Off-Balance Sheet Arrangements

The Company does not engage in any off-balance sheet financing arrangements.

Critical Accounting Policies

Management's discussion and analysis of financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses and the related disclosure of contingent assets and liabilities. Management bases its estimates and judgments on historical experience and on various other factors that it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Management believes that the following accounting policies are the most critical to aid in fully understanding and evaluating our reported financial results, and they require management's most difficult, subjective, or complex judgments, resulting from the need to make estimates about the effect of matters that are inherently uncertain.

Consolidation

The consolidated financial statements include the accounts of HQI and all of its wholly-owned subsidiaries. Intercompany balances and transactions have been eliminated.

GAAP requires the primary beneficiary of a variable interest entity (a "VIE"), to consolidate that entity. To be the primary beneficiary of a VIE, an entity must have both the power to direct the activities that most significantly impact the VIE's economic performance, and the obligation to absorb losses or the right to receive benefits from the VIE that are significant to it. We provide acquisition financing to some of our franchises that results in some of them being considered a VIE. We have reviewed these franchises and determined that we are not the primary beneficiary of any of these entities, and accordingly, these entities have not been consolidated.




                                       29

Business combinations We account for business acquisitions under the acquisition method of accounting by recognizing identifiable tangible and intangible assets acquired, liabilities assumed, and non-controlling interests in the acquired business at their fair values. The purchase price exceeding the fair value of the identifiable tangible and intangible assets acquired and liabilities assumed is recorded as goodwill. We expense acquisition related costs as we incur them.

Revision

During the fourth quarter of 2019, we identified a misstatement in the amount presented in our due to franchisee liability reported in prior years. The misstatement resulted from an accumulation of errors related to transferring items from the franchisee settlement statements to the Company's general ledger. We determined these errors accumulated prior to 2018. The accumulated error would have been material to the financial statements as of December 31, 2019 if we applied it in its entirety to them.

Pursuant to the guidance of Staff Accounting Bulletin No. 99, Materiality, we concluded that the errors were not material to any of our prior year consolidated financial statements. The accompanying consolidated balance sheet as of December 31, 2018 includes a cumulative revision relating to this misstatement.

This revision did not have any material effect on income from operations, net income, or cash flows, nor did it affect our past compliance with debt covenants. This misstatement had no effect on our cash balances.

The following table compares previously reported balances, adjustments, and revised balances as of December 31, 2018.




                      Previously
                       reported 2018 Adjustment   Revised 2018

Balance sheet changes Due to franchisee $620,385 $1,810,063 $2,430,448 Retained earnings 5,783,996 (1,810,063) 3,973,933

Accounts receivable and allowance for doubtful accounts Accounts receivable consist of amounts due for labor services from customers of franchises and of previously company-owned offices. At December 31, 2019, substantially all of our accounts receivable were due from franchises. At December 31, 2018, approximately 99% and 1% of our accounts receivable were due from franchises and previously company-owned offices, respectively.

Through our franchise agreements, we own the accounts receivable from labor services provided by our franchises. Accounts receivable that age beyond 84 days are charged back to our franchises. Accordingly, we do not record an allowance for doubtful accounts on these accounts receivable.

For labor services provided by previously company-owned offices, we record accounts receivable at face value less an allowance for doubtful accounts. We determine the allowance for doubtful accounts based on historical write-off experience, the age of the receivable, other qualitative factors and extenuating circumstances, and current economic data which represents our best estimate of the amount of probable losses on these accounts receivable, if any. We review the allowance for doubtful accounts periodically and write off past due balances when it is probable that the receivable will not be collected. Our allowance for doubtful accounts on accounts receivable generated by company-owned offices was approximately $168,000 and $-0- at December 31, 2019 and December 31, 2018, respectively.

Revenue Recognition Our primary source of revenue comes from royalty fees based on the operation of our franchised offices. Royalty fees from our HireQuest Direct business line are based on a percentage of sales for services our franchisees provide to customers and usually range from 5% to 8%. Royalty fees from our HireQuest business line are 4.5% of the payroll we fund plus 18% of the gross margin for the territory. Revenue is presented on a net basis as agent as opposed to a gross basis as principal, and recognized when we satisfy our performance obligations. Our performance obligations take the form of a franchise license and promised services. Promised services consist primarily of paying temporary employees, completing all payroll related statutory obligations, and providing workers' compensation insurance. Because these performance obligations are interrelated, we do not consider them to be individually distinct and account for them as a single performance obligation. Because our franchisees receive and consume the benefits of our services simultaneously, our performance obligations are satisfied when our services are provided. Franchise royalties are billed on a weekly basis. We also offer various incentive programs for franchisees including royalty incentives and other support initiatives. Royalty fees are reduced to reflect any royalty incentives earned or granted under these programs. Additionally, we provide franchise royalty credits and incentives. These credits and incentives are provided to drive new location development, organic growth, and to limit workers' compensation exposure. Franchise royalty fees are presented net of these credits and incentives.

Service revenue consists of interest we charge our franchisees on overdue customer accounts receivable and other miscellaneous fees for optional services we provide. Interest income is recognized based on the effective interest rate applied to the outstanding principal balance. Revenue for optional services is recognized as services are provided.




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Workers' compensation claims liability We maintain reserves for workers' compensation claims based on their estimated future cost. These reserves include claims that have been reported but not settled, as well as claims that have been incurred but not reported. Annually, we use third party actuarial estimates of the future costs of these claims discounted by a 3% present value interest rate to estimate the amount of our reserves. Quarterly, we use development factors provided by a third-party actuary to estimate the amount of our reserves. We make adjustments as necessary. If the actual cost of the claims exceeds the amount estimated, additional reserves may be required.

Workers' compensation Risk Management Incentive Program We pay our qualifying franchisees an amount equal to a percentage of the premium they pay for workers' compensation insurance if they keep their workers' compensation loss ratios below specific thresholds. This program, which we refer to as the Risk Management Incentive Program, incentivizes our franchisees to keep our temporary employees safe and to control their exposure to large workers' compensation claims.

Notes Receivable Notes receivable consist primarily of amounts due to us related to the financing of franchised locations. We report notes receivable at the principal balance outstanding less an allowance for losses. We charge interest at a fixed rate and interest income is calculated by applying the effective rate to the outstanding principal balance. Notes receivable are generally secured by the assets of each location and the ownership interests in the franchise. We monitor the financial condition of our franchisees and record provisions for estimated losses when we believe it is probable that our franchisees will be unable to make their required payments. Our allowance for losses on notes receivable was $-0- at December 31, 2019 and December 31, 2018.

Fair Value Measures Fair value is the price that would be received to sell an asset, or paid to transfer a liability, in the principal or most advantageous market for the asset or liability in an ordinary transaction between market participants on the measurement date. Our policy on fair value measures requires us to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The policy establishes a fair value hierarchy based on the level of independent, objective evidence surrounding the inputs used to measure fair value. A financial instrument's categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The policy prioritizes the inputs into three levels that may be used to measure fair value:

Level 1: Applies to assets or liabilities for which there are quoted prices in active markets for identical assets or liabilities.

Level 2: Applies to assets or liabilities for which there are inputs other than quoted prices that are observable for the asset or liability such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical assets or liabilities in markets with insufficient volume or infrequent transactions (less active markets); or model-derived valuations in which significant inputs are observable or can be derived principally from, or corroborated by, observable market data.

Level 3: Applies to assets or liabilities for which there are unobservable inputs to the valuation methodology that are significant to the measurement of the fair value of the assets or liabilities.

Discontinued Operations During the quarter ended September 29, 2019, we sold substantially all of the offices acquired in the Merger. Accordingly, the assets and liabilities, operating results, and cash flows for these businesses are presented as discontinued operations, separate from our continuing operations, for all periods presented in our consolidated financial statements and footnotes, unless indicated otherwise.

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